Tuesday, September 4, 2007

Sub-prime mortgage crisis explained

I'm sure you are a ware of the recent turmoil in the mortgage segment of the real estate market and are concerned how it will affect you.

A bit of recent history... Delinquencies on the sub-prime segment of the mortgage market have been rising nationally over the past nine months. This had been a slow progression and growing concern in the lending community. Bank regulatory guidance on sub-prime lending had been issued to most lending institutions and the sub-prime sector seemed to be contained. However, delinquencies on "Alt-A" production have also been rising more than investors anticipated, and in the last month several headline events have occurred and the markets reacted very negatively. This has created a "liquidity crunch," specifically for lenders that need to sell loans that are not saleable to Fannie Mae, Freddie Mac or Ginnie Mae.

Residential mortgages ultimately go to one of three primary places:

  • Quasi-government agencies such as Fannie Mae, Freddie Mac or Ginnie Mae
  • Bank portfolios
  • Private institutional investors, primarily as securities sold on Wall Street.

We have seen almost no changes for mortgages that fall into the first two categories, either in underwriting guidelines or in pricing. It is the private "Wall Street" market that has changed dramatically. Investors have lost confidence in the credit performance of all sub-prime, and more recently, "Alt-A' and even prime Jumbo loans, and have stopped buying them. Many mortgage lenders rely exclusively on this portion of the market to sell their mortgage loans so they can reinvest (lend) additional funds to the next borrower. Because that market has virtually stopped, most non-bank lenders have been forced to raise rates to uncompetitive levels and some have already gone out of business.

The major areas of negative impact are with sub-prime, "Alt-A," stated-income, and low-doc loans. The market for fully documented jumbo mortgages (loans over $417,000) has seen prices deteriorating as well, i.e., interest rates to the borrower rising and closing costs going up. In addition, the low down-payment programs (80% first mortgage & 10% or 15% second) are no longer available through most brokers and n0n-bank originators. The reason for this is that in order to offer a competitive price, the second mortgage must be placed in portfolio - a capability that generally only banks enjoy.

What should you be doing?

Review your loan information (if you're a borrower) or your pipeline of pending sales (if a Realtor or Mortgage Broker) and re-confirm your mortgage commitments. A loan that was approved a month ago may not be approved today. If a loan was not locked-in several weeks ago, the price may be significantly higher, potentially jeopardizing the approval and ability to close the transaction. Obviously, knowing this sooner rather than later, before a deal falls apart at the closing table, gives you options.